Friday, December 17, 2010

A few years ago I travelled by local transport (mostly boats along the Mekong) from Saigon to Siem Riep. I traveled with my wife and my then seven year old son. Hotels ranged from about a dollar a night to 170 dollars a night. (We splurged at the Victoria Chau Doc which felt like the best hotel I had ever stayed in - but probably was only in contrast.)

We hired locals to show us what they did for fun - which largely revolved around cock-fighting and any other form of gambling they could find and moonshine. They even bred fighting fish for gambling.

I sipped (small amounts of) moonshine and watched Cambodian soldiers play poker and boules.* The soldiers left their machine guns in a pile whilst they gambled. They would not let me photograph them because they were on duty. (They had machine guns - so I went along with that request.)

The moonshine was bad. Really bad. Kill-people sort-of-bad. Drinking it in quantity would be like having your brain smashed around a gold brick and then twirled with some slightly rotten pineapple chunks. It told me that the real game in alcohol in developing countries is to get people off the (literally) poisonous once-distilled moonshine and get them onto double or triple distilled stuff that comes in bottles. The biggest selling liquor label in the world used to be Johnny Walker Red Label. Now it’s Bagpiper - a genuine Indian whiskey. Bagpiper is one of the few liquors I would argue saves lives. The alternative is moonshine and with regular and sometimes very large death-tolls.

In China they didn’t take to whiskey like the Indians. Instead they drink Baijiu. The alcohol is usually sold as a wholesale ingredient - and blended under lots of brand names. The commercially made (and multiple distilled) grain alcohols will be displacing moonshine for years to come. There is good quality growth there.

Which brings me to China New Borun (BORN). BORN is a controversial stock floated on the US exchange earlier this year. It had reputable brokers backing the IPO. [The prospectus is part of my holiday reading!]

The prospectus tells us that edible alcohol is sold by grade (A, B, C) with A grade being more refined and hence tasting better. This company produces B and C grade with increasing focus on the B grade. Absolut Vodka it is not - but whatever - it is likely far better than the vat of rice and rotten pineapple by the Tonle Sap I tried. Here is what the company says about its production.

We currently own and operate two facilities: one in Shouguang, Shandong Province and the other in Daqing, Heilongjiang Province. Our Shouguang facility has an annual production capacity of 160,000 tons of corn−based edible alcohol (90,000 tons of Grade B edible alcohol and 70,000 tons of Grade C edible alcohol). Our Daqing facility currently has an annual production capacity of 100,000 tons of corn−based edible alcohol (70,000 tons of Grade B edible alcohol and 30,000 tons Grade C edible alcohol). We are constructing an additional 120,000 tons of capacity (all Grade B edible alcohol) at our Daqing facility, currently expected to commence commercial production in December 2010. According to the Frost & Sullivan Report, we are the largest privately−owned corn−based edible alcohol producer operating in Shandong Province and Heilongjiang Province. Our Daqing facility is licensed to build up to 330,000 tons of production capacity of edible alcohol. Based on data from the Frost & Sullivan Report and our knowledge of our industry, we believe we will be the largest producer of corn−based edible alcohol in China, in terms of current known production capacity, following complete development of the Daqing facility.

In China the numbers can bamboozle you - but I am not used to talking about 380 thousand tons of edible alcohol. That will supply an awful lot of drunks. I was trying to work out just how many - but the text of the prospectus does not make clear whether they are talking about metric tonnes or US short tons** as would be measured in America. (The spelling is different - so I would normally go with the spelling - except that China would measure this in metric and some diagrams later in the prospectus are specifically labelled as “metric tons”.)

And here is the diagram that was labelled “metric tons”. It purports to show edible alcohol consumption in China. They mean grain based stuff sold into the Baijiu market.

Lets take the 2012 estimate. 7.3 million tonnes of alcohol per annum. That is 7.3 billion kilograms of alcohol per annum. That is of course on top of the moonshine, wines, beers and imported spirits that the Chinese drink. (The growth in this chart must be moonshine replacement.) This is a lot of alcohol even for 1.3 billion people. It is more alcohol than the Chinese drink according to WHO statistics. Indeed it suggests that the Chinese are as drunk as the Russians (something that casual observation of culture makes you think is unlikely).

There is just over a quarter of a kilogram of alcohol in a (standard 700ml) bottle of Absolut Vodka. So this represents say 29 billion bottles of vodka. One company - China New Borun - is - according to its prospectus - responsible for about 1.2 billion of these bottles.

By contrast, the biggest selling liquor labels in the world (Bagpiper, Johnny Walker Red) sell about 20 million bottles (ahem: cases) each. China New Borun claims to be an absolute global behemoth in the business of getting people smashed. (Even with the bottles-cases correction China New Borun is a global behemoth in getting people stewed.)

Of course all the consumption in this note - and China New Borun's capacity - represent 2012 estimates. Maybe - like everything else in the world - the Chinese are building excess capacity in getting people pissed, legless, bladdered, trashed and otherwise off-the-wagon.

Lesson of all this: there are either a lot of drunks in China or the statistics are wrong. Maybe there are a lot of drunks in China and the statistics are wrong. Maybe the statistics are compiled by the drunks. Maybe the excess alcohol capacity is supplied by drunks. Whatever - when it comes to statistics and China you need to take them with a good stiff glass of Baijiu. If the statistics are in a prospectus trying to sell you stock - take two glasses of Baijiu. If that does not work - resort to moonshine.

John

*The French left baguettes, boules and train-tracks. The train-tracks have since been converted to bamboo railways.

Wednesday, December 15, 2010

I am back in Australia after my trip to the USA and I am taking a few days break. Its lunch time – and I have been reading the annual report of a once highly valued internet company* whilst I wait for the heat to die down. It is too hot to stay at the beach – but I am cool from my most recent dip in the Pacific Ocean. I can hear waves crashing on the shore.

I write to make an observation – one for all the currency speculators out there. We stopped for a meal on the way South. South of Sydney (hence with cooler water) is the unfashionable part of the New South Wales coast. A beach-town cafe in decidedly middle class Kiama – and without water views is now as expensive as a cafe on the Upper West Side of Manhattan. (The fish and chips are better in Kiama though.)

Some of this price level is due to wage structure – but most of it is new. Australia is just expensive and getting more so – and the Central Bank (justifiably) feels the need to raise interest rates. Australia is now a very expensive place to visit and I do not recommend it except for the very wealthy.

It's hard to call the end of the Australian bubble – but the boom and prices have gone far beyond rational. I don't see what breaks it other than an end to the Chinese construction boom. These prices are the downside of being China's coal and iron ore mine. In America I saw no obvious inflation between trips. On the South Coast of New South Wales I can't say the same thing.

If you are an Australian and you are not in the process of shifting 25 percent of your asset base offshore you are probably remiss. And if you are a currency speculator liking the carry on Australian government bonds then it has been a great trade but I hope you get to the exits early.

Meanwhile you can enjoy ordinary ice-cream cones in small coastal towns at US $5.30 each.

John

*There is a blog post in that internet company – but it will have to wait for the new year. I want to talk to management to hear their side of the story first.

Wednesday, December 8, 2010

Just over a year ago I wrote a letter to regulators detailing a fraud at an Australian fund manager (Astarra/Trio Capital). This was the Bernie Madoff of Australia. (This required no special genius on my part. I was tipped off by a blog reader.)

Saturday, December 4, 2010

The subject of income distribution is taboo in the USA. On my blog readers noted a simple comparison of the price of laundry in London and New York will do to prove the point. However when reposted on Business Insider (with a more inflammatory header) the hostile-reactometer went off-the scale.

And it did that even though I was careful to point out some of the many benefits of a wide income distribution. There are benefits of non-strict labor laws which make certain businesses possible in America that are very difficult in Europe or Australia.

We have a friend who has a massively cyclic business. (The business involves capital equipment for the construction industry.) They pay their staff very well. (Many receive $100 per hour though most receive far less.) However their staff numbers shrink by 80 plus percent whenever business turns down (regularly enough) and rise by 500 percent when business turns up. The volatility in the business is shared with the staff rather than being absorbed entirely by the owner.

In extrema this business could not exist in (say) France because no business owner could (or would) absorb this volatility themselves. The owner openly says he does not know how people do business in France. Sharing the pain works.

This applies across the whole labor market - the highly flexible working conditions of America are a strength of American business even though at times they result in amazingly large income variability and some very low wages.

Still - and carefully thinking about it - I am not sure what the real cause of low-end wages is.

Many readers thought (logically enough) that immigration levels drove bottom-end wages - after all the women washing my clothes were Chinese and the nannies were largely Hispanic. Some on Business Insider thought me an idiot for not just accepting that. (Australia is - they observed - becoming more closed to immigration.)

I am not so sure.

The US population is 307 million and it grows about 1 million per annum - most of which is driven by immigration - some of it illegal.

Australia has a population of 21.9 million - and the immigration rate has been over 200 thousand people per annum of late. (Its about to drop for political reasons.) The population growth rate in Australia is three times the USA - almost entirely driven by immigration including a lot of immigration of people who would expect to earn below average wages.

In Australia there are more immigrants to do my laundry per head of population than in the USA.

And yet bottom end wages have never been quite as pressured as in the USA - and frankly - I do not understand why.

This is interesting in the case of Australia but truly important for Europe. Europe opened itself to massive internal immigration from poor countries and did not have a collapse in the bottom end wage structure.

The GDP per capita in Bulgaria is under $7000 USD per annum. Bulgaria is poorer than Mexico on that measure. And the border is open. Romania is similar (with a larger population). And sure the low wage workers who clean my hotel room in London are likely to be Bulgarian or Romanian but - whatever - they haven’t managed to drive down the price of laundry.

And that I do not quite understand. It is making writing the European follow up post difficult.

Thursday, December 2, 2010

I am on a trip to the United States to raise money for my funds management business. Its like an endless series of first dates. If things go well you get a second date. If things go poorly you get jilted - and usually you are not told why you are jilted. One prospect however told us that they were not going to invest with us because they did not like my accent. (I am an Australian - get used to it.)

Anyway I stayed with some friends who turned out (somewhat to my surprise) to be more prosperous than I imagined. They lived in a three level beautiful inner Chicago house designed by a very stylish architect. I was there getting over jet-lag and cooking in their beautiful kitchen. (I cooked braised pork with sage, shallots, and star anise.)

I also did my laundry. Much to my surprise my hosts did not have an ironing board.

I told my wife by phone - and she thought they must be absurdly wealthy - but then even the wealthy in Australia have an ironing board. Sure they were a highly motivated and extremely hard working professional couple and ironing was hardly a priority - but it was still strange.

And then in Brooklyn - a week later - I worked it out. I dropped my laundry off at a Chinese Laundromat and got back a few pressed shirts, my jeans, socks etcetera and paid $11.75. I figure the same basket would cost me $28 in Australia. Why would you bother to wash and iron if you were prosperous and laundry was that cheap... moreover there was at least two laundries between my home and the subway. I did not need to go out of my way.

This was all because of something I knew on paper - but the price of washing made it personal. Australia does not have large numbers of very low wage employees and - even in the days machines - laundry is a labor intensive and non-traded commodity. Laundry is expensive in Australia because the person doing it expects to make $15 plus per hour. Sure minimum wages are a little lower than that - but most lowly skilled workers are paid more than the minimum. The laundries I pass in Brooklyn take the clothes to a large warehouse-type room filled with Chinese women who speak little English and who almost certainly work for less than minimum wages. And a upper middle-class New Yorker either never sees them and can ignore them. A large low-wage group make the (very rich) lifestyles of the American elite possible. They make it possible to never do your washing, eat in up-market restaurants, have nannies look after your children and have a material standard of living that even very rich Australians might envy.

If you are minimum wage worker and you have a job it is clearly much better if you live in Sydney or Melbourne than Brooklyn. At the moment of course Australia is the far-better bet - low wage workers are more likely to find a job down-under and the job is certain to pay better. But that is not the pattern of the last twenty years. Mostly Australia has run unemployment a percent or more higher than the United States and there has been less low-pay work. (Of course the reason why there is less low pay work is that we do our own ironing, cooking, cleaning and child minding as a response to the high price of these services.)

I don’t want to say that this is just a result of minimum wage laws. I was careful to note that in Australia the norm would be to pay more than the minimum and less than the minimum is common in the US. Whatever this is an extreme society and the results are - to my eyes - often peculiar. Lightly traded labor intensive goods and services are - at least to my eyes - startlingly cheap in America. And whilst laundry is my case example - the one I most enjoy is berries. Strawberries and raspberries are highly labor intensive fruit. Picking them is backbreaking and/or prickly work and they need to be transported to very tight timetables. Like laundry the cost in New York is about a third that in Sydney. And whilst clean clothes are nice - raspberries are wonderful. So a little self-consciously I literally enjoy the fruits of American inequality.

America was not always this unequal. Australia has got more unequal in my adult life. And inequality is not all bad - not only do I eat fine raspberries - but it makes some people more productive if there is a (financial) tree to climb. Its just - along with the side of the road Americans drive on and the endless adverts for medical services the most visible difference between Australia and America. I can’t help but be aware of it.

John

PS. Part II will be about traded and non-traded goods in the Eurozone. And the price of laundry...

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.